By: Sarah Thornton
Reaching the higher earnings threshold before the end of the personal tax year (05 April 2011) is a tax planning opportunity which affects a number of our clients.
The higher earnings threshold for 2010/11 is £43,875. If your total earnings from all sources is below this, you pay an effective rate of tax of 0% on any dividend income received. When your earnings exceed the threshold you will pay an effective rate of tax of 25% on any dividends received above £43,875.
To avoid paying the 25% higher rate dividend tax once you reach the higher earnings threshold, your best option is usually to stop paying yourself. Below are all the options available to you.
1. Continue to pay dividends: There are personal tax implications in doing this, with the net effect being you will have to pay the dividend tax of 25% on any dividends you receive over the higher earnings threshold. This is payable through your personal tax return, and will be payable by 31 January 2012 on any dividends paid over the threshold in the 2010/11 tax year.
It is your responsibility to keep this tax amount aside as you will have to pay the tax from your personal bank account, not the company account.
Providing you keep your ‘My Earnings’ page up to date online, you will be able to accurately track your personal earnings and view the approximate amount of personal tax you are liable for in section 1 “Summary of your 2010/11 personal earnings” of your online account.
2. Take a Loan from you ltd company: You can take a total Directors Loan of up to £5,000 without having to pay your company interest on the loan balance. But, a penny over £5,000 and you are required to pay your company interest on the entire loan balance, at 4.00%, to avoid a benefit in kind charge.
The good news is, you are effectively paying interest to a company owned by you. The interest income received by your company is taxed 21% – so the net cost of borrowing is 0.8% – (4.00% x 21%) = 0.8% – much better than 25% dividend tax. NOTE: If the loan is outstanding nine months following your company year end, the company will have to pay 25% of the outstanding loan balance as a tax to the HMRC. This is a ‘temporary tax’, and is repaid to the business by the HMRC once the loan itself is repaid.
Please contact us if you would like more information on this.
3. Stop paying yourself from your ltd company: Once you reach the threshold you can stop paying yourself until the new tax year starts on 06 April. Obviously this means if you have living costs that need to be met, you will need to find funds from other sources, or live off savings. This may not be an ideal scenario for some clients.